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What would happen to Petrol if….?

By Matt L, on February 18th, 2013

Over the recent week, the price of petrol has moved up close to its all-time record high, in nominal terms, and is sitting at around $2.20 per litre. Yet at the same time the New Zealand dollar is also close to an all-time high vs. the US dollar, sitting at around 85c. This raises an interesting question of what petrol prices would be like if our exchange rate wasn’t so good for imports. The good thing is we can make an educated guess thanks to the work the Ministry of Business, Innovation and Employment do in their weekly oil price monitoring. At a high level the price of petrol is made up of three components, the cost to import the fuel, our taxes and levies and the importer margin (which covers everything from distribution and retail costs to profits).

It is the first of these components – the cost to import the fuel – that is most directly affected by the exchange rate, and handily in its weekly data the MBIE include the average weekly exchange rate. From that we can work out what the cost per litre would be in US dollars and then reconvert that to NZ dollars at a different exchange rate. I worked it out for each week over the last three years for two scenarios – if our exchange rate vs. the US was 5c and 10c less than it is now. I have then applied the extra GST that would be paid to that figure to get a result. Averaged out over 3 years, this shows that if all other components stayed the same, with the only thing changing being the exchange rate, an exchange rate drop of 5c would see petrol increase by ~7.5 cents per litre. A drop of 10c would see petrol increase by ~16c per litre.

There are a few key things that could cause the dollar to drop. The first is if the NZ economy weakens, the second if the US economy improved. Not only would this see our exchange rate drop but it would also see the demand for fuel in the US increase. The third thing that could happen is a major economic or political shock overseas, for example a political crisis in the Middle East. As we know these things can happen quite fast and when they do, investors run away from higher risk currencies like the NZ dollar to the perceived safer economies such as the US, Japan and Europe.

In the case of a middle east crisis, that would have a double whammy of increasing the cost we have to pay not only due to the exchange rate but also in the raw cost as investors become worried about supply issues (there could actually be a triple whammy if we also had improvements in offshore economies, particularly the US as that would also drive up demand). If such things were to happen it would be hard to say just what price our petrol could rise to, but it is interesting to note that we have seen it before.

Back in the middle of 2008, just before the GFC hit, higher raw costs combined with a lower exchange rate (9-10c lower than now) saw the importer cost peak to 20-30c per litre higher than it is now. At the time the price at the pump reached $2.12 and the reason it was less than we have now is due to the other two main components – the taxes and levies, and the importer margin.

Looking at the taxes first, a couple of key things have happened since that time 4½ years ago. Increases in the Fuel Excise Duty (FED), along with the introduction of the Emissions Trading Scheme have seen fixed taxes increase by almost 9.5c per litre. Another key aspect is that over this time period GST has increased from 12.5% to 15% and of course GST is applied on top of both the importer costs and the other taxes.

There has also been quite a change in the level of importer margin. Remember that this isn’t just the profit margin but is used to cover the rest of the oil companys’ local operations, such as distribution and retail costs. Back in 2008 it was as low as 9c per litre however the long term average prior to that (and for a few years after) saw the margin sitting at around 14c per litre. In fact it didn’t reach over 20c per litre until the middle of 2010. In recent years this has changed – the average over the last few years has been ~21c per litre with the average over the last year up at ~24c per litre. I don’t know if the increase is due to a rise in the bottom line for these companies or if it is due to increased costs or perhaps compensation for the proliferation of discount fuel vouchers that are now in the market.

Thinking about the future there is one other factor that needs to be taken into account. Just before Christmas the government announced that starting 1 July this year – petrol would increase by 3c per litre every year for three years. It is to help pay for many of the uneconomic RoNS projects and is also partly to combat falling tax revenues due to people driving less. What all this means is that in a few years time we could quite easily see the price of petrol increase by as much as 30c per litre. That would put the price of petrol up around $2.50 per litre. This isn’t meant to be a kind of alarmist post and is really just to highlight that petrol could quickly rise. If this were to happen, it would be interesting to see what impact that would have on people’s preferences to drive. It’s also a great reason why we should be investing in modes of transport that give people more choice in how they get around.

One last point before anyone starts commenting that we are over taxed for petrol. The MBIE also produce this graph quarterly which shows that the fuel taxes we pay are still much lower than most other developed countries.

30 comments to What would happen to Petrol if….?

One slightly confusing thing is the US Dollar is a reserve currency where people run at times of perceived crisis. So oddly a low USD means the US is doing well, and that’s before they started printing money. This means that as the recovery in the US progresses the value of the US dollar will fall

Er, no. It is true thatt the USD is a home for panicking ‘hot’ money so tends to get bought in times of trouble but the corollary you describe is not the case. A stronger US economy will lead to a stronger USD, ceteris pairibus.

The other key point is the massive increase in fuel use by China. Depending on which report you read it is increasing exponentially at between 6 and 13% per annum and they are relying more and more on imported crude.

I don’t think that lower prices would be a good thing, but that doesn’t mean it won’t happen.

Set against this is the high NZ dollar and so on. Overall, I’d imagine real petrol and diesel prices in NZ won’t change massively over the next few years, partly because of the buffer provided by taxation.

Doesn’t fracking introduce additional costs to recovering the oil? Surely that has to add some kind of cost to the end price? Also, that does not allow for any additional opposition to fracking. Oh, and the government needs the taxation for the roads they have committed to so I cannot see that falling.

JohnP prices may fall but that cannot be caused by fracking because it is an extremely expensive technology that is only worth deploying in a high oil price market. It is, in fact, only the recent sustained high oil price that has made fracking [not a new technique contrary to many popular reports] possible to any degree. Not only has fracking been around for decades but so has knowledge of shale deposits like the Bakken. To illustrate this high cost problem is the fact that the US is currently producing about the same amount of oil as it did in 2000, but now using 25 000 wells to achieve this instead of the 5 000 it did back then.

So say there is a crash in the global crude price because of further economic contraction leading to a slump in demand, that would immediately make the US Tight oil plays [fracking] uneconomic and production would quite quickly wind down. Which would of course lead to a constriction in supply and most likely lead to a bounce in crude even in the new lower demand market. A picture like what happened after the 2008 USD 140 price spike which destroyed economic activity worldwide [especially in OECD countries] and demand enough to cause the crude price to slump…. only to slowly work back towards those heights again on market fundamentals.

And what are those fundamentals? Depletion. Depletion of the easy to extract super giant fields like the Ghawar in Saudi Arabia and the three fields that saved the west from high oil prices through the 1980s and 90s and broke the OPEC stranglehold on supply after the US all time peak in 1970: The North Slope in Alaska, Cantarell in Mexico, and the North Sea in Europe.

And fracking, or Tight Oil as it is more accurately known [because the oil is actually embedded tightly in the rock not held in reservoirs that can be more easily accessed] offers no kind of rate of production like those three fields did.

Anyway NZ buys crude on the global market [Tapis generally] and the decrease in imports to the US which is primarily from a decline in consumption because of economic contraction and a plunge in driving but also from the increase in Tight Oil from North Dakota and Texas has caused no decline in the figure we pay for our oil. Largely because the developing world, especially China and India, are buying any oil that is still available which is preventing any drop in the price.

A lot of the buzz in the news is very US-centric and frankly delusional but also not relevant. Even the average American doesn’t directly benefit from Tight Oil in the sense that it doesn’t make their pump price any lower. Sure it means there’s a bunch of roughnecks working out in the freezing badlands of North Dakota and incidentally a rail boom transporting the stuff [no pipelines there], but no huge change to the global demand/supply curve; hence the price.

Relevant: Even though the US has dropped consumption maybe 10% this century [from around 20mbpd to about 18]. Here’s China they’ve added more than three times that saving:

How’s this. In the year 2000, 2M cars were sold in China. Last year, over 18M cars were sold in China.

Also:
“Not at all. By industry convention, a market begins to show signs of saturation at 500 cars per thousand people. The U.S. boasts more than 800 cars per thousand. Now that’s one saturated market. The G7 average is over 600 cars per thousand. Poland raced from cars for functionaries only in 1990 to 450 cars per thousand average people today. Russia already stands at 225 cars per thousand. And how many cars does China have today?

63 per thousand, says my database. Some think it’s less. 63 cars per thousand stands for a market that sucks up cars like a dry sponge. And it does, as we saw last year.”

Faaaaark! Thems is scary numbers. We really need to get off this oil addiction, we cannot compete with China for oil; they will out bid us.

And this is without mentioning the cruel logic of the Export Land Model which describes how the growth in consumption in the exporting countries shrinks the available net exports quite apart from field depletion:

This from physicist Geoffrey West who developed the ELM:

An excerpt from a paper, with 24 graphs, that I am working on, in which I will formally introduce and explain the ECI concept (Export Capacity Index):

Rising Unconventional Production Versus Declining Net Exports

Some major net exporters, e.g., Canada, are showing increasing net exports, primarily as a result of increasing production from unconventional sources.

However, Canadian net oil exports should be put in the context of regional data, and combined net oil exports from the seven major net exporters in the Americas in 2004 (Canada, Mexico, Venezuela, Colombia, Argentina, Ecuador and Trinidad & Tobago) fell from 6.1 mbpd in 2004 to 5.1 mbpd in 2011 (BP, total petroleum liquids). In other words, rising Canadian net oil exports have so far only served to slow the post-2004 regional decline in Western Hemisphere net oil exports.

And of course, many people believe rising production from shale resources around the world will result in an indefinite increase in global crude oil production, which perhaps might offset the ongoing post-2005 decline in Global and Available Net Exports. However, it seems unlikely to me that a production base with a steady increase in underlying decline rates, and with thousands and thousands of shale oil wells quickly headed toward stripper well status (10 bpd or less), will be able make a material long term difference in the global net export situation, especially in the context of rising demand in the developing countries. In addition, operating costs in most other prospective shale plays around the globe are higher, and often much higher, than in the US Lower 48 area.

Furthermore, the increase in US oil production also needs to be put in the context of production declines in other OECD countries. For example, US total petroleum liquids production in 2011 was 7.8 mpbd, only slightly above the US 1999 production rate of 7.7 mbpd, but over the same time period, 1999 to 2011, UK total petroleum liquids production declined by 1.8 mbpd, down from 2.9 mbpd in 1999 to 1.1 mbpd in 2011. From 2006 on, the UK was a net oil importer, showing rising annual net oil imports, through 2011.

In any case, for the average American consumer, unless they directly or indirectly benefit from US oil and gas activity, an increase in US crude oil production, to a level that it still well below the 1970 US crude oil production peak, is largely irrelevant, and the average consumer is far more focused on recent near record high gasoline prices at the pump.

I do think your not far of the mark with petrol reaching $2.50 per litre in the near future. The USD is very likely going to strengthen making our imports
more expensive and with the additional excise taxes that are to come.
It’s quite ironic that the governments road building plans needing higher revenues from excise taxes may make driving on these new roads a luxury
for the rich, and is our public tranhsport capability ready for that!!

I’m not bold enough to make any predictions on oil price; up, down, flat, or bouncing around like a fart in a bottle [it’s all conceivable] but your last point is the issue here. Current government policy is totally insane if you imagine that they are working for every citizen, but quite understandable if you accept that they are only working for the already wealthy and Big Trucking…. the majority is subsidising both.

You mean that guy in the Sky TV ads of old who walks town going “la la la la la la la” to avoid finding out the truth (the final score in the game he’s trying to get home to watch on a free to air delayed broadcast)?

This post raises a point that when you think about it is potentially disastrous for us, yet gets scant attention. Less attention than, say, an asteroid impact. Never mind a 5-10 c per litre increase.. I would think a $ 5-10 per litre increase is within the range of possibilities that need to be considered.

On the other hand a decrease much below the present price seems unlikely.. almost all the new oil sources depend on price per barrel upwards of $ 80, so even if (big IF) they deliver the quantities claimed over time, that alone wouldn’t cause the price to revert to the lows of the 90s.. Presumably anindustrial downturn might do the trick. But it would have to be pretty substantial.. those China car numbers and oil import quantities are amazing.

Pretty sorry effort. While acknowledging something we all know; petrol is not getting cheaper, this purpose of this piece is to sooth us into accepting:
1. Prices are at some unnatural peak [subtext; not going to keep going up]
2. Only high because of irresponsible spending by Johnny Foreigner [not because structural supply/demand issues]
3. Or political unrest by same Johnny Foreigner [with our oil, and they think their problems are important!]
4. Nothing can done [don’t worry; keep driving]
5. Even less can be done about Climate Change [blame China]

I read an article in the last few months (maybe on http://theoildrum.com ) that suggested prices are unlikely to go too far away from $100 per barrel. The argument:
Keeping it from going lower: cost of production for many new sites is high (Tar sands in Canada, Shale in the US, deep sea around the world), so they need it at $100 to be economic. OPEC wants to maximise profit, so will limit supply to keep prices up.
Keeping it from going a lot higher: the producers are very aware that if oil goes too high, alternatives become viable. For many alternatives (solar, wind, hydro), the costs are mainly capital costs, so once it’s built, then they ain’t going back to oil, so the secret is to not let it be economic to build it in the first place.

At $100 we can all afford enough oil to fry the planet, so a bit depressing really.

But renewables are already cost effective for electricity generation. NZ could be 100% renewable will the will, from the current 80%, fairly soon and easily.

Liquid fuels for transport is a trickier problem, they are really convenient, and we have a huge sunk infrastructure that is dependant on them and that we are feverishly adding to under this government.

It is possible to adjust away from this vulnerable dependency but it will take time and we have to start now.

We are currently doing the COMPLETE OPPOSITE of what we should be doing with the RoNS. Hopefully we won’t have to wait for the next big crisis to realise this. Won’t happen under current management as their view is faith based.

Clarification: renewables are easy for us, and we can get to 100% renewable electricity, but renewables are very difficult for nearly every other country in the world. And certainly not competitive compared to coal.

Example: the US has wind resources around the Rockys, but that’s a long distance from their population centres, and their transmission network is decrepit.

Too much of the conversation is dominated by US conditions, and they are so wasteful. But anyway we need to look to our competitive advantages and one of them is in renewable electricity. Why aren’t we maximising this? Oh yeah…

Well there is an argument that aluminium is a means of storing electricity: Congealed energy. Way more important to not be blowing valuable polluting oil on taking the SUV to work and back… or to drop the kids at school, etc Our kids and grandkids will marvel at our profligacy….

Provided that the opportunity cost of doing so, is not higher than the value of the said electricity.

Example of this, I hear you say?

Well how about the country spending $Billion on buildling a new Gas or non-renewable (Coal!?) powered electricity generation plant, (paid for by the power users).

Meanwhile the country benefits to tune of a few millions of net exports of the electricity embedded in the aluminium smelted from imported ingredients.
Resulting in a value add to NZ Inc of the value of the electricity in said aluminium.

It would appear that a sensible policy would be to not only watch the price of petrol, but to also watch the price of copper (especially copper wire) battery materials (mostly Lithium) and materials used in making electric motors (alloys used for making magnets). Biofuel prices seem to be really fuzzy and more expensive than oil sucked out of the ground, and would appear to have long-term potential to drop with appropriate technology.

I have not seen any consideration of the effects of price rises of any these materials on transport, private or public.

What are the world reserves of these materials? Who controls them? What exploration is occurring? Who stock-piles these materials? Should the New Zealand government be investing in research on this rather than worrying about drilling for oil?

And Lloyd considering that mining is basically a very heavy lifting way of turning diesel into whatever you are digging for the unrestrained lift in energy costs pushes all those other goods up too. As well, of course, of the cost of food. So supply/demand imbalances of vital energy sources is an order of magnitude more of a problem that other goods. Especially ones that are very hard are to substitute.

Money properly understood is an energy token [energy makes food and everything else], and credit is a token for future energy. Economists largely ignore this because they are taught in Econ 101 that everything is substitutable and so they forget that goods have different qualities.

The US is in the process of swapping gas [Natural Gas] for coal for electricity generation [and are now exporting their coal], but they are struggling mightily to substitute their oil use with anything. And we aren’t even trying.